Risk Profiling

Logic dictates that the more capital an investor risks losing, the greater the potential rewards of that investment need to be. In other words, risk and return are two sides of the same coin. The purpose of our risk profiling exercise is to assess the tolerance of an investor to adverse outcomes.

The investment objective favoured by most private clients is to keep pace with the equity markets on their way up and match returns from cash when equity markets are falling. Unfortunately stock markets cycles are notoriously difficult to predict and, unless a risk profiling exercise is undertaken, investors tend to end up adopting a "balanced" multi-asset class approach as an unsatisfactory compromise.

Risk reward trade off

Logic dictates that the more capital an investor risks losing, the greater the potential rewards of that investment need to be. In other words, risk and return are two sides of the same coin. The purpose of any risk profiling exercise should be to assess the tolerance of an investor to adverse outcomes.

Multiple time horizons

The concept of investment risk only has validity in the context of a defined time horizon. But whilst an investor might theoretically have a time horizon of several years or even decades, it is difficult not to be swayed by the prevailing market sentiment. Unless this issue is dealt with explicitly, investor dissatisfaction is almost guaranteed.

Risk of loss

Most investors equate risk with the likelihood of suffering capital loss. Often measured in monthly or annual terms, risk of loss is in essence a function of the unpredictability of returns over time. To achieve above cash returns over the long term, risk needs to be embraced rather than avoided, within the comfort zone of the investor.

Risk of disappointment

This type of risk relates to the style of an investment manager. Contrast an index tracker with a concentrated 20 stock portfolio. The tracker follows the index up and down. The concentrated portfolio will probably behave very differently to the index. Understanding the style of each manager is an essential part of assessing manager performance.

We recognise that every client has a unique set of circumstances and aspirations. The science of portfolio modelling can suggest combinations of cash, bonds, equities, alternative investments and other financial instruments that will in theory meet a client’s objectives. However, the art of portfolio design is to help a client to select a portfolio structure that meets their specific quantitative and qualitative criteria.